It’s not a secret: OPEC has painted itself into a corner by relying exclusively on supply control to be able to manipulate international oil prices in a way that is favorable for its members. Right now, prices are depressed and that has nothing to do with supply. Could OPEC’s grip on oil prices be slipping irreparably?
When OPEC first announced that its members had agreed to put a cap on their production to reverse a steep drop in prices, it worked. Prices had been pushed to lows last seen more than a decade ago by the U.S. shale boom and OPEC’s own attempt to halt it by turning the taps on to maximum flow. When OPEC said it would reduce this flow, prices rebounded, providing much-needed relief to oil-reliant economies in the Gulf—it also provided relief to oil producers around the world, including the U.S. shale patch.
The shale patch recovered so well that now U.S. oil production is at an all-time high with the country last year becoming the world’s largest producer. Meanwhile, OPEC and its partners led by Russia decided to cut again. This time, however, the cuts didn’t work. Prices remained subdued save the occasional short-lived rally. While it’s true Brent and WTI are both higher than they were before the second round of cuts was announced, the international benchmark is much lower than OPEC’s largest producers, notably Saudi Arabia, need it to be.
The reason these cuts aren’t working is that market movers are not watching them. They are watching the tariff match between Washington and Beijing—a match that could hurt global oil demand. According to forecasters, it is already hurting it and as a result, it is hurting prices.
“OPEC’s burden is to show that it still has the appropriate tools to arrest price declines driven in no small part by White House policy,” RBC’s head of commodity strategy, Helima Croft, said in a note to clients as quoted by CNBC this week. “It may prove easier to clean up the physical market than to overcome skepticism about the ultimate efficacy of its strategy in the age of Trump,” Croft added.
"The recent crash of 2014-16 demonstrated the reduced impact that OPEC now has on oil prices. While OPEC was announcing production cuts, the US onshore shale boom easily counteracted any upward price pressure. Currently, sanctions on Iran and Venezuela continue to undermine the influence of OPEC," Jason Lavis, partner at oil industry platform Drillers.com told Oilprice.
When OPEC+ met last December, the partners agreed to take off a combined 1.2 million bpd from the global oil market. This July, they agreed to extend the cuts to the end of the year or even early 2020. Yet the cartel’s total production is actually down by more than 1.2 million bpd: U.S. sanctions on Venezuela and Iran have hurt these countries’ production rates severely. Even so, Brent is stubbornly hovering around $60 a barrel. The trade war worry, coupled with the relentless rise in U.S. production, has played a bad trick on OPEC.
It seems the only way to achieve higher prices would be to cut deeper. It is the only way that would make sense seeing as the maximum-production strategy failed spectacularly. However, deeper cuts would mean loss of market share, and any change in prices might not be substantial enough to justify this loss. In this context, it is highly doubtful that some OPEC members—and Russia, too—would agree to reduce their oil production by much more. This means OPEC might just need to sit on the sidelines and watch the trade war developments hoping for a deal: that could be the miracle the cartel needs to get the higher prices its members’ economies rely on. Whether a trade deal would push prices up to the $80 level Saudi Arabia needs is doubtful but in the end, anything higher would be better.
By Irina Slav for Oilprice.com
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